Private Equity is making quite a buzz in the trade industry. I can hardly go a day without it being brought up — whether it is on a trade podcast, in an interview with a potential job candidate or someone on LinkedIn reaching out to approach me about it.
Even though private equity is by no means something new, PE has been active in many other industries for a long time, PE has been making more moves in the plumbing and HVAC industry in recent years.
To get things started I will briefly explain what PE is and in order to do this with at least some objectivity I will start with a shortened description straight from ChatGPT and then add some of my own input:
Prompt: Please explain to me what Private Equity is.
ChatGPT: “Private equity refers to a type of investment where funds are directly invested in private companies.”
Here’s a breakdown of how private equity works:
Private Equity Firms: These are investment firms that raise capital from various investors, such as pension funds, wealthy individuals, and institutional investors.
Acquisition: The private equity firm uses the pooled capital to acquire stakes in private companies. The goal is often to take control or significantly influence the management and operations of these companies.
Value Creation: After acquisition, private equity firms work to improve the company’s value. This can involve restructuring, improving efficiency, expanding markets, or other strategic changes.
Exit Strategy: After enhancing the company’s value, the private equity firm looks to sell for a profit.
Returns: Investors in the private equity fund receive returns based on the profits made from these sales.
Private equity can offer high returns, but it’s also risky and involves a longer-term commitment, usually ranging from 5 to 10 years. It’s often used to fund startups, expand companies, or turn around struggling businesses.
BREAKING IT DOWN
I’d like to break it down a little further and give my perspective on what it means for: PE, stakeholders, middle management, frontline employees, and customers.
For PE, acquisitions in the trade industry space represent one thing — money. They aren’t acquiring companies to make the trades (or the world) a better place. Their entire reason for existence is to turn a profit. The way they do that is to underpay for a company in hopes of making it perform “better” (at least from a profit and loss perspective) and then turn around and sell it again. That is how they make their money. Here are some of the most common ways they do this:
1. Cut overhead by eliminating and/or consolidating roles which results in less jobs in that market and an increased workload on the remaining staff with no commensurate increase in pay to make up for the additional duties.
2. Centralize or offshore administrative jobs such as customer service representatives, dispatchers, accounting, human resources, and so on, again resulting in a hit to the company culture and less jobs available in that market.
3. Make big changes to other fixed cost expenses such as cell phone providers, health insurance, retirement, payroll software, under the pretense of getting better results with more buying power. The pitch is that with all of the companies under the same PE group pooling their resources they can negotiate for better rates. In theory this sounds good. In practice it is not always the case. In my first hand experience, the health and retirement benefits got worse. The match and vesting period for the retirement became less favorable for the employees and the health benefits got worse and more expensive.
4. Pay raise freezes.
5. Wage compression — which is where you let longer-term, higher-paid employees go with the purpose of replacing them shortly thereafter with someone who is cheaper.
6. B shares or B stock — this helps to retain key employees based on a promise of a later payout. The reason that I list it here is that it will then be used as a reason to not give raises or to pay more to existing staff as they absorb more responsibilities that are incurred from downsizing the overhead team.
SIDE EFFECTS
The max potential upside from all of this is increased profitability resulting in a higher valuation and quicker turnover to a different PE group which really only benefits the PE group and shareholders. Everyone else at the company has the joy of doing it all over again with the new PE group who will be looking to increase profitability and decrease costs — and the cycle continues.
Another common thing that happens is that the PE groups think that the same strategy and style that has worked in other markets can just be copied and pasted in any new market that they make an acquisition in. This often results in dissonance and can be detrimental to the acquired company’s culture.
One of the first questions I ask potential job candidates is, “What has you looking for other job opportunities?” The most common response by far is something like, “My company was purchased by a private equity group a few months back and I hate it there now.” When I ask them to elaborate, common themes emerge: I’m just a number now, I no longer have a voice there, they are changing the pay structure, benefits are worse, they are laying lots of people off, all things that are straight from the PE playbook.
I have not done an extensive interview process by any means, but of the many prior business owners I have spoken with over the last few months every single one has told me that if they had it to do over again they would not sell to PE. One of them even shared with me that they were no longer going to be allowed to give out the Christmas bonuses to their employees that they had been doing for years. They also let me know that they planned on doing it anyway.
THE OTHER SIDE
All of this is creating a great opportunity for small to medium sized businesses. I talk to many people at companies like that all over the country and they are thriving. Employees are engaged and part of the process. They are valued and have agency because they work with the decision makers on a daily basis rather than having to answer to a PE group that is in another state. PE is driving experienced employees away in droves which is making it much easier to hire qualified employees. Customers get a better experience because they are being served by employees who are engaged.
You may be reading this and thinking, “What’s your point Westie, and also you seem pretty biased.”
Fair assessment.
My main point is education and telling both sides of the story. PE acquisitions may not always be bad, but they are most definitely not always good.
As to me being biased, I am. Absolutely. It is actually impossible to be completely unbiased, humans are not capable of it. Everybody has an agenda, they are just not always willing to share what it is. Mine is to educate tradespeople on the dark side of PE and give enough information for them to make an informed decision on where they stand with it.
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Westie Magnuson is the chief people officer for Cornel’s Plumbing, Heating & Air based in Washington County, Oregon.
